Final text of European Market Infrastructure Regulation released.

Transcription

1 March 2012 Final text of European Market Infrastructure Regulation released. Final text of European Market Infrastructure Regulation released On 29 March 2012, the European Parliament (the Parliament ) adopted the final text of the Regulation on OTC derivative transactions, central counterparties and trade repositories 1 (commonly referred to as the European Market Infrastructure Regulation or EMIR ). This follows the publication by the European Commission (the Commission ) of its proposal nearly 18 months ago (in September 2010), and a keenly negotiated and intensely political trilogue process. Contents Final text of European Market Infrastructure Regulation released... 1 Key changes made to EMIR during the trilogue process 3 Comment... 6 EMIR at a glance: > CCP clearing: EMIR requires counterparties to clear all OTC derivative contracts that meet pre-defined eligibility criteria through an authorised CCP. This requirement will be introduced across all asset classes and all users of OTC derivative contracts (whether a financial firm or a nonfinancial firm), although there are some limited exemptions for nonfinancial firms, pensions schemes and certain intra-group transactions. > Eligibility: EMIR introduces a top down and bottom up procedure for assessing the eligibility of a class of OTC derivative contracts for mandatory clearing, and in which ESMA has the final say. > FX: EMIR s recitals clarify that foreign exchange ( FX ) contracts may be excluded from the classes of derivative contracts subject to the clearing obligation, although they may however still be subject to collateral and/or capital requirements for non-cleared OTC derivative contracts. > Non-financial firms: EMIR imposes information reporting obligations on non-financial firms, and clearing obligations where they meet certain clearing thresholds (such thresholds to be determined by ESMA in technical standards). > Risk mitigation for non-cleared OTC derivative contracts: for noncleared OTC derivative contracts, EMIR requires all counterparties (including those otherwise exempted from the clearing obligations, such as non-financial firms and pension schemes) to put in place appropriate 1 Click here for texts approved by the Parliament on 29 March 2012 including EMIR (p.22) Finalised text of European Market Infrastructure Regulation released 1

2 procedures to measure, monitor and mitigate risk by using, for example, electronic confirmations, and daily marking to market, margining and additional capital requirements. > CCP regulation: EMIR introduces an initial authorisation requirement and a framework of common requirements for CCPs regarding their systems and resources to ensure that CCPs are regulated on a consistent basis. ESMA will have a central role in the new regulatory colleges to be established by a CCP s competent authority, with each college including members representing not only the national competent authority(ies) supervising the CCP, but also other Member States competent authorities supervising entities which might be impacted by that CCP's operations (e.g. large clearing members, trading venues, interoperable CCPs, central securities depositories etc.). Additional provisions have been inserted in EMIR to address concerns over college members refusing authorisation to a CCP for self-interested, national protectionist reasons. > Trade reporting and trade repositories: EMIR imposes an obligation on all market participants to report details of derivative contracts to trade repositories (regardless of any clearing thresholds or eligibility of the relevant derivative contract for mandatory clearing), and introduces a registration regime for trade repositories. EMIR will enter into force 20 days after its publication in the Official Journal of the European Union, which is expected in June or July 2012, with the bulk of its related implementing and regulatory technical standards expected to come into force by the end of The Commission s work has been largely motivated by the agreement of the G20 leaders at Pittsburgh in September 2009 that required that all standardised OTC derivative contracts should, where appropriate, be cleared through a central counterparty ( CCP ) by the end of The EU is now playing catch up with the US in putting in place its framework legislation to meet its G20 commitments, the US having moved on to rule making and implementation of its Dodd Frank Act ( Dodd-Frank ). Congratulating the Parliament on its vote, the European Commissioner responsible for the Internal Market and Services portfolio has re-stated the will of the European Union to respect its financial market related G20 commitments and invited the other G20 members to do the same. A considerable amount of detail in EMIR has been left to the European Securities and Markets Authority ( ESMA ) to provide in technical standards. These standards are of vital importance for market participants to understand the nature and extent of their obligations under EMIR. They cover matters such as the level of the clearing thresholds applicable to non-financial firms, the setting of capital and collateral charges for non-cleared OTC derivative contracts, and the procedure for assessing eligibility for clearing of an OTC derivative contract. The deadline for ESMA to finalise these standards is 30 September 2012, which unfortunately gives very little time to market Final text of European Market Infrastructure Regulation released 2

3 participants not only for consultation but also for implementation of these new standards. Below is an explanation of key changes made to EMIR as a result of the negotiations carried out in the trilogue process commenced in October Key changes made to EMIR during the trilogue process > FX: additional provisions in EMIR s recitals now clarify that, where the risks associated with a particular asset class relate to settlement rather than counterparty risk - as it is the case for FX contracts - clearing may not be appropriate to address those risks. EMIR provides that ESMA should take this into account when determining which classes of derivatives are to be subject to the clearing obligation and may decide not to include that particular asset class - such as FX contracts - as a result. EMIR s recitals add that the regime for such contracts should rely on preliminary international convergence and mutual recognition of the relevant infrastructure (with reference to future US Treasury decisions). However, to the extent FX contracts fall within the scope of OTC derivative contracts under EMIR, they may still be subject to collateral and/or capital requirements pursuant to the risk mitigation requirements applicable to non-cleared OTC derivative contracts. > Intra-group transactions exemption: exemptions for intra-group transactions may be available where entities are in the same consolidation. EMIR clarifies that entities will be considered to be in the same consolidation if they are included in a consolidation in accordance with the Seventh Company Law Directive 2 or the International Financial Reporting Standards ( IFRS ). Where the parent of the relevant entity(ies) has its head office in a third country, entities will be considered to be in the same consolidation if they are included in a consolidation in accordance with Generally Accepted Accounting Principles of that third country determined to be equivalent to IFRS. Counterparties must also give their national regulator prior notice in writing at least 30 days before using the exemption. The availability of the exemption is subject to conditions relating to risk management procedures and legal certainty. There are different processes for the national regulator to determine whether the conditions for using the exemption have been fulfilled as between financial firms and nonfinancial firms. > Non-financial firm exemption: changes made during trilogues include: - the provision that non-financial firms rolling average position over 30 working days must exceed the clearing threshold before the clearing obligation bites (rather than their positions having to exceed the threshold for 30 days over a 3 month period), 2 Directive (83/349/EC) Final text of European Market Infrastructure Regulation released 3

4 - the extension from 3 months to 4 months of the time period in which non-financial firms have to clear all relevant contracts from the date of exceeding the threshold, - the recognition that non-financial firms may use OTC derivative contracts to cover themselves against risks linked to their treasury activities as well as their commercial activities. This is clearly intended to catch large corporates taking steps to e.g. manage treasury risks as well as commercial risk in their core business, - the provision that, for the purpose of setting the clearing threshold for non-financial firms, methods of risk mitigation used by such firms in the context of their usual business activity should be recognised. These concessions undoubtedly reflect vigorous lobbying by nonfinancial firms adversely affected by the legislation. Note however that although these carve outs assist so far as the clearing obligation is concerned and the expense of providing margin, proposed amendments to the Capital Requirements Directive ( CRD IV ) will impose what are viewed by many non-financial firms as punitive capital charges for non-cleared OTC derivative contracts. > Pensions light touch regime: pension schemes as defined in EMIR are exempt from the clearing obligation only for three years from the date of entry into force of EMIR in respect of OTC derivative contracts entered into to reduce their investment risks. However they will still be subject to the reporting obligation and the collateralisation and/or capital requirements for non-cleared OTC derivatives. > Covered bonds/cover pools for covered bonds: an addition to EMIR s recitals now provides that ESMA should take into account the specific nature of derivatives concluded with covered bond issuers or with cover pools for covered bonds. This is clearly a concession won by the covered bonds market, for whom it is currently very unclear how EMIR can be sensibly complied with. > Risk mitigation for non-cleared OTC derivative contracts: EMIR now provides that ESMA should proactively monitor activity in bilateral contracts on an on-going basis and identify any activity that may pose systemic risk, and take steps to prevent opportunities for regulatory arbitrage arising between cleared and non-cleared contracts. ESMA may, for example, review margin requirements to address any such issues. ESMA, EBA and EIOPA have already published a joint discussion paper with their views and proposals for collateral and capital requirements, which will be of particular importance for market participants entering into the more bespoke types of OTC derivative contracts, as these are unlikely to become subject to the clearing obligation. Final text of European Market Infrastructure Regulation released 4

5 > CCP regulation: additional wording in EMIR s recitals now provides that no proposal or policy of any member of a college may directly/indirectly discriminate against another Member State as a venue for a CCP. This is no doubt an attempt to address concerns raised about national protectionism in the context of CCP authorisation. ESMA is to participate in every college and an authorisation of a CCP can only be refused on mutual consent of the whole college. Transitional provisions provide that CCPs which have been authorised by a national regulator prior to EMIR coming into force must apply to ESMA for authorisation within 6 months from when technical standards as specified in EMIR are adopted (including measures relating to the clearing obligation). In an attempt to appease concerns raised by the industry that CCPs may in fact become an alternative source of systemic risk and may themselves become too big to fail, an addition has been made to the recitals that risk management strategies must be sufficiently sound so as to avoid risk for the tax payer. This can be seen as essentially a policy steer. EBA has already published draft technical standards on the capital requirements for CCPs. > CCP transparency: EMIR now imposes new obligations on CCPs to disclose publicly the volumes of cleared transactions on an aggregate basis, breaches by clearing members of CCPs admission criteria which will be established by CCPs to ensure clearing members have sufficient financial resources and operational capacity to meet their obligations (except where such disclosure might cause disorder in the markets etc.), and details of the levels of protection/segregation CCPs provide and their respective associated costs. This should also include a description of the main legal implications of the respective levels of segregation. This is clearly intended to encourage the right kind of competition between clearing houses e.g. a race to the top so far as levels of protection are concerned for clients. > Third country CCPs: the basic regime for third country CCPs to obtain authorisation to provide clearing services in the EU has stayed the same as the previous Council text, but EMIR does provide that CCPs from third countries will be recognised in the EU if the legal regime of the third country provides for an effective, equivalent regime. The recitals clarify that a system shall be considered effective and equivalent if it ensures that the substantial result of the applicable regulatory regime is similar to EU requirements and should be considered effective if those rules are being applied in a consistent manner. This is a more pragmatic approach to equivalency than we have seen with other EU directives, the Markets in Financial Instruments Directive ( MiFID ) proposals in particular, although it remains to be seen (even with this slightly lower hurdle) how easy it will be for third country regimes to gain equivalency. A further condition that must be fulfilled before a third country CCP can be recognised is that it must also have equivalent anti-money laundering systems to the EU. Equivalency in this context means third country equivalence under the 3rd Money Laundering Directive. Final text of European Market Infrastructure Regulation released 5

6 > Validity of contracts: an additional provision confirming that a breach of EMIR will not affect the validity/enforceability of any OTC derivative contracts, nor give rise to any compensation rights, was inserted into the Council text. It will be very much welcomed by the industry. > Trade reporting and trade repositories: EMIR requires market participants (including non-financial firms irrespective of any clearing thresholds) to report details of all derivative contracts (whether cleared or not cleared) to trade repositories. EMIR also introduces a registration regime for trade repositories. Reporting may be delegated, and counterparties and CCPs shall ensure that the details of their derivative contracts are reported without duplication. There is also a new record keeping obligation - records of derivative contracts plus any modification must be kept for at least five years after termination of the contract. > Retrospective reporting: a new retrospective reporting obligation has been imposed on all derivative contracts that were entered into before the date of entry into force of EMIR and are outstanding on that date. > Technical standards: as noted above, ESMA (along with EBA and/or EIOPA for certain aspects of EMIR) is tasked with producing a considerable quantity of technical standards in order to put the flesh on the bones of the obligations established in EMIR. Most of these standards need to be finalised by 30 September Although ESMA has already begun this process with the publication of a discussion paper on certain draft technical standards, including those relating to the arrangements that meet the requirements of indirect clearing arrangements and an indication of the clearing threshold for nonfinancial firms, as well as a joint EBA/EIOPA discussion paper on risk mitigation techniques for non-cleared OTC derivative contracts, there is still a long way to go, and precious little time to get there. Given the significant impact EMIR and related technical standards will have on the market, it is a pity that ESMA and the market are forced to work with such tight time frames for consultation and implementation. This was a concern eloquently voiced by a group of financial markets trade associations in a letter dated 17 January 2012 to the Commission, the EU Presidency and the Parliament. Comment It is clear that EMIR and Dodd-Frank together will have the following effect on the OTC derivatives market and its participants over the coming months: > acceleration of the move towards the use of CCPs for clearing, including the expansion of indirect client access to clearing houses through clearing brokers, > increased competition between European and US clearing houses as they compete to expand the scope of their offerings, Final text of European Market Infrastructure Regulation released 6

7 > onerous new requirements for non-financial firms that are major participants in the OTC derivatives markets, such as energy companies. There are likely to be consequences for the real economy, although these are difficult to accurately assess at this stage, > increased costs for both cleared OTC derivative contracts - through margin requirements and other CCP costs - and non-cleared OTC derivative contracts - through collateralisation and/or capital requirements, as well as transaction reporting costs for all derivative contracts. However, it will not be possible to assess the full impact of EMIR or to identify precisely the differences between EMIR and the derivatives provisions of Dodd-Frank until ESMA s work on the technical standards progresses further. All of the above will be exacerbated by the short lead time before EMIR and related technical standards come into force. In particular, resources within firms and CCPs are likely to be seriously strained by a need to get signed up to clearing members and CCPs, and make all the required systems changes by the end of In addition, there are a number of further EU workstreams which, once completed, all have the potential to have an impact on the OTC derivatives market. These include: > provisions in CRD IV imposing higher capital requirements for noncleared OTC derivative contracts, for which the Commission made its legislative proposal in June 2011 and on which it is aiming to conclude the negotiation process by this summer/autumn, > MiFID reforms that include: requirements for trading of standardised derivatives on organised trading venues; transaction reporting of OTC derivative contracts; pre-trade transparency requirements and harmonised post-trade transparency requirements in the near future, > extension of the scope of the Market Abuse Directive to OTC derivative contracts related to underlyings traded on a regulated market or MTF. Final text of European Market Infrastructure Regulation released 7

8 Contacts For further information please contact: Michael Kent Partner, Financial Regulation Group, London (+44) Peter Bevan Partner, Financial Regulation Group, London (+44) Carl Fernandes Partner, Financial Regulation Group, London (+44) Harry Eddis Counsel, Financial Regulation Group, London (+44) Robin Maxwell Partner, Financial Regulation Group, New York (+1) Authors: Anne-Laure Condat, Kirsty Gibson A This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts, or contact the editors. Linklaters LLP. All Rights reserved 2012 Linklaters LLP is a limited liability partnership registered in England and Wales with registered number OC It is a law firm authorised and regulated by the Solicitors Regulation Authority. The term partner in relation to Linklaters LLP is used to refer to a member of Linklaters LLP or an employee or consultant of Linklaters LLP or any of its affiliated firms or entities with equivalent standing and qualifications. A list of the names of the members of Linklaters LLP together with a list of those non-members who are designated as partners and their professional qualifications is open to inspection at its registered office, One Silk Street, London EC2Y 8HQ or on and such persons are either solicitors, registered foreign lawyers or European lawyers. Please refer to for important information on our regulatory position. We currently hold your contact details, which we use to send you newsletters such as this and for other marketing and business communications. We use your contact details for our own internal purposes only. This information is available to our offices worldwide and to those of our associated firms. If any of your details are incorrect or have recently changed, or if you no longer wish to receive this newsletter or other marketing communications, please let us know by ing us at marketing.database@linklaters.com. Pauline Ashall Partner, Derivatives and Structured Products, London (+44) pauline.ashall@linklaters.com Mark Middleton Partner, Derivatives and Structured Products, London (+44) mark.middleton@linklaters.com Michael Voisin Partner, Derivatives and Structured Products, London (+44) michael.voisin@linklaters.com One Silk Street Final text of European Market Infrastructure Regulation released London EC2Y 8HQ 8 Telephone (+44) Facsimile (+44)